By Carl Lachman, CFP®, MBA

Have You Seen Ken Fisher’s Ads?

If you spend any time watching financial news television or browsing financial websites, you have probably seen ads from Fisher Investments where founder Ken Fisher says or writes something like “I hate annuities and you should too!”

Mr. Fisher is passionate about the subject! Why would anyone lead a crusade against the annuity, an otherwise boring financial product? Doesn’t he have something better to do with his time?

The Fisher Machine

Ken Fisher has been a prominent fixture in the financial world for a very long time. He had a column in Forbes magazine, for instance, for more than 30 years. He has written many thoughtful things over the years, giving much good advice on investment strategy. His company, Fisher Investments, is one of the largest independent, fee-only registered investment advisors in the United States. However, he is rather relentless in marketing his company through advertising, direct mail, online, radio, television, etc.

Fisher Investments is one of our company’s competitors. Eclectic Associates is also an independent, fee-only registered investment advisor. And, like Fisher, we are fiduciary advisors that put our clients’ interests before our own. Fisher does not receive sales commissions, and neither do we. However, while Fisher offers only investment management, Eclectic offers a comprehensive list of financial planning services in addition to investment management.

While we might not use the word “hate,” we agree with Fisher that annuities should be avoided. Why?

Annuities Are Sold Products

Have you ever heard the expression “If you are a hammer, everything looks like a nail?” The thought is that the hammer can do only one thing, and it sees everything in the context of that vision. Annuity salespeople are similar. They are paid every time they sell an annuity, so they see annuities as the solution to every financial problem you have.

Do you need income? Buy an annuity. Do you need to pay less in taxes? Buy an annuity. Do you need financial security? Buy an annuity. Do you need better investment returns? Buy an annuity.

Annuity salespeople are some of the highest paid salespeople in the financial world, so the best salespeople are attracted to the business of selling annuities. Thus, annuity salespeople are extremely persuasive in explaining how the purchase of an annuity will solve your problems. Yet, this is rarely true.

Annuities Are Expensive

When a $100,000 annuity is sold, the salesperson usually is paid between $5,000 and $7,000. Wow is right! And, if the annuity sold is, for instance, five times bigger ($500,000), the sales commission goes up proportionately five times to $25,000–$35,000. Like a pro golfer winning a PGA tournament, an annuity salesperson is yelling, “Winner, winner, chicken dinner!” every time they make a sale. Pro golfers and annuity folks get big paydays.

The reason that annuity companies can afford to pay so much in commissions is because they take in high annual fees from annuity holders, usually in the range of 2% to 2.5% each year. Those fees are collected no matter what happens to the value of the annuity, and they usually happen in the background of the product, rather than appearing on an invoice each year where the annuity owner can easily see how much they are paying.

Part of the high annual fee pays for a type of insurance that is almost never used. Often, 1% per year is paid for a type of insurance that pays out the original annuity purchase amount, if the annuity is worth less than that and the annuity holder dies. The heirs will get made whole if the annuity performs terribly and then the owner dies. This is an extremely unlikely event, but if it is a big concern, it usually would be cheaper to keep that 1% and purchase a term life insurance policy. The economics of buying such insurance through an annuity don’t make sense.

Annuities Are Poor Investments

Annuities are also expensive because they are so often poor investments. Once a person buys an annuity and is locked in to the product, the annuity company is not motivated to make the investments perform for the owners. The company is motivated to keep profits high for itself, but to do so, they need to create investment scenarios that minimally perform according to the annuity contract but no more. As long as the contract is fulfilled, that’s all the company needs to do.

Annuities Are a Big Bet on One Company

Frankly, a case can be made that maybe annuities should not be called investments at all. Really, they are a contractual agreement where the annuity purchaser is paying for a certain range of financial results from a financial company.

True, annuities are offered by only life insurance companies and are regulated on a state-by-state basis, but that regulation does not necessarily make annuities safe or guaranteed. You can lose money on annuities, and sometimes annuity companies go out of business, with annuity holders getting left with less than they thought they were owed.

When you buy an annuity, remember that you are taking on a concentrated risk with one company. 

Annuities Are Hard to Exit

The high commissions paid for annuity sales are, of course, the powerful motivation behind all of the advertisements and sales tactics used by salespeople. The high commissions are also the reason that annuities have surrender penalties. Some surrender penalties last for seven years, but there are rather egregious annuities with surrender penalties that last 15 years!

The surrender penalty is the process by which the annuity company gets paid back for the big commission they paid to the salesperson. If they are going to pay such high commissions, they want to get reimbursed if you get out of the contract after one year. The surrender penalty is the way the company makes you pay for the commission they fronted.

Annuities Are Complex

Annuity contracts are a prime example of just how creative lawyers can be if they are motivated. The contracts are complex and are mostly written to the benefit of the annuity company. The complexity makes annuities hard to understand by the typical purchaser and tend to overwhelm even people with the smartest of minds. In fact, relatively few attorneys understand annuity contracts when they try to read them!

An example of the complexity is illustrated by an annuity contract I read a couple of years ago. The annuity was sold as the answer to many problems: guaranteed income in retirement, high returns, tax savings, easy withdrawals, etc. But, if you dug into the details, you saw that the buyer would be severely penalized if any tiny misstep was taken in removing money from the annuity.

This annuity allowed a little money to be taken out each year, but if the owner inadvertently removed one additional dollar above the contractually allowed annual amount, a penalty would be imposed not just on that withdrawal, but all withdrawals in PAST years!

Annuities Are Not the Best Answer

Although annuities are sold as the best answer to every financial problem, they are not. A little information can show almost anyone that they have other options for their money that cost less, have better returns, are more flexible, and save more on taxes.

Annuities tend to prey on people’s fear of the unknown. The guarantees offered by the company seem to eliminate all of the fears that the purchaser has. But, our advisors have found that if we educate our clients just a little bit about annuities and the other investment options they have for their money, the fear almost always disappears and is replaced with confidence.

Every investment has an element of risk, even annuities. Annuities might be sold as eliminating risk, but they just trade some risks for other risks. Commonly, the new risks are overpaying for financial results, incurring penalties to get to money when you need it, being unable to stay ahead of inflation, losing assets due to corporate bankruptcy, and lacking asset growth in good financial markets.

A comparable diversified allocation of investments using mutual funds or exchange-traded funds (ETFs) can provide lower costs, avoid penalties, offer daily cash liquidity, give the ability for higher returns, provide a good fight against inflation, can be tax efficient, and avoid dependency on the promises of a single corporation.

What If You Already Own an Annuity?

Don’t beat yourself up. It’s not the end of the world. Annuities are far from ideal, but if you own one or many, you have ways to get out of them and move to better solutions. The details of your annuity contract will dictate the options you have, and there are some fee-only financial advisors who have the expertise to help you understand those options.

At Eclectic Associates, we have helped hundreds of clients understand and avoid annuity pitfalls, so you might want to have us take a look at your annuity. There isn’t a silver bullet that solves every annuity problem, but we will help you understand the best options you have.

Always Know How a Financial Professional Gets Paid

Maybe the most important message about avoiding annuities is that we all need to understand how people in the financial world get paid. It helps us understand the motivation they have for the advice they are giving.

If a financial professional gets paid a commission when you sign a contract, then they might only be worried about you signing the contract and not thinking of your best interests in the long term. They are not a fiduciary. Rather, they are the hammer and you are the nail. Ouch!

Schedule a 15-minute discovery call with a fee-only financial advisor to discuss your personal situation.